Pensions reform

Have to say I’m not all that sure about it. For it’s very difficult indeed to work out how long you’re going to live and thus at what speed you should spend a pension pot. And thus the use of the insurance industry through an annuity.

On the other hand this makes clear one thing:

The individual will have a choice of three simple routes to withdraw the remainder: taking it as cash, subject to ordinary rates of income tax;

Tax relief on pensions contributions is not in fact tax relief. It’s tax delay. So, if Ritchie and his ilk want to cut that amount of delay then they’ve also got to work out some method of compensating at the other end of the process. Some special rules on tax relief on the payment of the pension itself.

45 thoughts on “Pensions reform”

  1. Having spent the last couple of years on the buy-side of the financial world looking at pension type stuff, I can say that this undoubtably a good thing for the consumer.

    Being forced into an annuity without the ability to time the purchase properly, whilst being offered very low rates etc only served to hurt consumers.

    My guess is that we will see a “new” industry springing up based on the the self-insurance model, focusing more on returns (which will hopefully make the asset managers focus more on that as well) and timed drawing down of pensions to mimic the annuity without being locked into it.

  2. There are three possible scenarios:
    1. Our pensioner underestimates his lifespan, spends all his money before dying, and falls back on the state.
    2. Our pensioner overestimates his lifespan, doesn’t spend it all, and the next of kin inherit what’s left.
    3. Goldilocks scenario: Our pensioner estimates perfectly, or buys an annuity.

    Given that actually having a decent pension implies a propensity to save, I imagine scenario 2 will be the most common.

  3. If most every crinkly I’ve known is a guide, erring on the side of caution is the default position. Rainy day money; shit happens, be prepared; funeral money; etc. You shake your head when the will is read and wonder why they didn’t treat themselves when alive, but that’s not how the psyche works.

  4. In your heart, you know Ritchie and their ilk will be all for double-dipping — all your money belong to Curajus State, and all that.

  5. @ Andrew M

    Goes back to what I was saying…it’s not that difficult to set up a simple spreadhsheet with assets, expected returns and an actuarial table to do this for yourself to maximise your drawdown without wiping out the pension. It’s the basis of liability driven investment, which is beocming ever more common place. I doubt it will be long before financial advice takes this form to guide people through the process.

  6. Next step, increase the pension age. Pensions should be for those unlucky few who live too long after stopping work.

    When most people died at 65, then retiring at 65 was OK. With medical advances people now live an extra 30-40 years. Nearly the same as their working life. With those medical advances most of the people who live into their 80-90s are actually very healthy and active and able to work. So allow people to carry on working till they can’t, don’t force people to stop working.

  7. Tyler

    I’m probably on the opposite side of your transactions!

    I agree that this move is a good thing. (Although it did cause a bit of a flap in the office yesterday).

    Personal view, and not fully thought through yet, is that there will be some combination of the scenario you describe (effectively a mass-market drawdown vehicle), some self-managed funds and still a large number of the risk averse taking an annuity.

    There will be a number blowing the pot, but these people are likely to have small pensions savings anyway (and by small I mean less than £50k) so the annual annuity they would have got would have been small in any event. Spending £30k and not getting the £1000 per year annuity isn’t going to make a big difference to them; in any event they’ll be relying on their state pension.

    (This is assuming current savings rates remain unchanged; I have no idea if this move will increase or decrease the rate)

    I’ve said before that the pensions and life insurance industry has been in need of a massive shake-up and hopefully this will be the trigger.

  8. I’d have thought that Tim would be all for this change.Those who find the thought of managing their own investments can still buy an annuity, whilst those who want to do things on their own can do so. Freedom of choice, and all that.

  9. interesting what happened to the share price of the providers just afterwards. Would suggest a view that George has just killed a monopoly.

  10. Tyler, sure, you can set up such a spreadsheet. But the chance the expected return will match the actual return, AND that the lifespan will match the actuarial average for any one pensioner must be pretty low.

    So a large proportion will, as Andrew says, over or underspend. Whether that’s better than buying an annuity at a bad time, or dying the day after you bought it is another matter.

  11. Could this be seen a smart move in the short term at least for the economy? Surely the effect is going to be that people who have small pension pots are going to take the lump sum and spend it? As GlenDorran says, the amount of income from a small pot will be minimal anyway, so why not take the capital and buy a new car, holiday of a lifetime, do up the house for the last time etc etc? Thus releasing a wave of grey pound spending into the economy.

    Of course there’s still the long term to worry about, in that lots of people will have spent their capital and then rely on the State instead, but what politician ever worried about that?

  12. Its not just tax delay. If it did not exist people would be saving after tax and then paying income tax on top.
    Also as savings in a pension grow from investment returns before they finaly get taxed the Treasury gets a bigger sum

  13. @ Luke

    indeed this is the case for the individual. However, the same calculations also give you the rough margin for error. Extending the model for a pensioners real expenses with some CPI+ bases annual increase makes it even more sound. We’ve been running these things for a while now, and you’d be surpised how accurately you can plan despite so many unknowns.

    The flexibility of the drawdown offers a big advantage though, allowing people to “retire” but leave their pension invested instead of buying the annuity. It’s a simply massive change in investment income over the life of a normal drawn pension.

    If nothing else, it means a pensioner on his death bed can draw down his life savings rather than effectively handing over to the insurer, which to me removes one of the great unfairnesses of the pension system – that the pensions weren’t transferable down generations.

  14. The majority of people will be substantially relying on the state pension – that’s unavoidable and there’s actually nothing wrong with it (in my view, anyway, pensions is one of those things that ‘the collective’ ought be doing) and, so, the state pension will probably always have to be enough to live on.

    That means that whatever private provision we make on top is a ‘nice to have’, and it’s quite right that people are empowered to do what they please with it. Those with minimal pots (and there’s going to a lot more of them thanks to Auto-enrolment) can do the holiday/mortgage/coke&hookers thing, and people with useful pots can make their own choices.. and nobody will be destitute at the end of it because of that state backstop.

    Personally I’d fancy a hybrid. I’d want to cash in some of my pot to get an annuity to lock-down a desired standard of living (which is more than the state pension would afford me) but retain control over the rest.

    Like Alistair Harris says, the market reaction says a lot. Forcing people to buy something never works in the interests of consumers. Annuities should still be perfect vehicles for a lot of people.. but now they have to give us reasons to buy them beyond ‘you don’t have a choice, mate.. lolz’

  15. Two questions – do you still get the 1/4 lump sum tax free?

    What’s stopping them taking the lot out and using it to stoke another housing boom?

  16. For people on the “small pot” side, do the changes blur the line between saving in an ISA versus a pension pot?

    I know of quite a few people who already treat their (stocks and shares) ISA as ‘their pension’ (in the same way that some BTL landlords regard their property as ‘their pension’). But I have long thought they’re exposing themselves to political risk – if ISAs become seen as tools of tax avoidance by the moderately wealthy, their continued tax exemption is uncertain. I wouldn’t want to bet they’d still be around in anything like current form in 30+ years.

    On the other hand, governments are always going to be keen to encourage folk to save and invest, and ISAs and their previous incarnations have been part of the landscape for a while now. So I can see why people can rely on them. I get the feeling this year’s changes may see more people divert more of their money towards towards NISA rather than self funding a pension even if the new pension arrangements are more attractive on paper.

  17. I agree that its not too hard to manage your own pot – I’d been preparing for that. It’s a fairly simple spreadsheet -life expectancy data is not hard to come by and even with the previous draw down rules etc it wasn’t hard to achieve a better income than an annuity, Take out your 25% tax free and dribble it into iSAs (quicker now at 15K) – then shop around for the pension fund manager with good performance and low charges for the 75% balance

    I saw another useful suggestion – for those with sizeable pots – draw down the 1/4 tax free and lend it at 4-5%% interest to your kids as a mortgage booster – fairly cheap to have a charge drawn up over property is you insist on security etc – better return than the pensioner bond.and keeps it in the family

  18. Rob

    Yes, 25% can still be taken tax-free. Anything above that will be taxed as income.

    In relation to a new housing boom: see the comments earlier about the relative size of pension pots. Most people won’t be able to buy a property outright with the proceeds. Will banks be willing to give BTL mortgages to pensioners, especially if there is a flood of new money coming into the market? Although presumably LTV on such loans would be very low. (Genuine question; I don’t know – I am not a banker)

  19. Tyler,
    – “it’s not that difficult to set up a simple spreadhsheet”
    It still eludes Mr Worstall though….

    Rob,
    Yes, the housing market will get a nice little boost in April 2015 when these rules come into force. In that respect our Gideon has missed a trick: he could have introduced the rules sooner to give a pre-election housing boost.

  20. As Andrew M and Bernie G suggest, the worries about people blowing the lot are, I think, over-blown. Someone who saves a substantial pension pot must have built a set of cautious and prudent attitudes towards money over the course of a lifetime. Those attitudes and habits won’t change overnight.

    My only quibble with the Chancellor would be that he hasn’t considered compulsory workplace pensions. His policy change is predicated on the kind of economics-cum-psychology I outlined in the previous paragraph, which I think is pretty sound; but compulsory saving is unlikely to engender the kind of prudence which people need to develop for this policy to be successful.

    Like TTG, I would think the optimum strategy for a pensioner is not all-or-nothing in any direction, but rather to take some amount of annuity income to guarantee a certain income on top of whatever the state offers and then take one’s chances with the returns on the rest. (I’m not likely to face this choice as I’m in a DB scheme, and it’s quasi-public sector to boot.) People can also annuitise at a time which suits them: for instance, annuitise a little at retirement, and then do another wodge when managing the investments becomes too time-consuming (and stick the rest in fire-and-forget funds).

    Overall, it’s a very good policy. What a shame government won’t develop its ideas on trusting the public more broadly!

  21. “a simple spreadhsheet with assets, expected returns and an actuarial table”: get thee behind me, Satan. Simple spreadsheets are a bloody menace, inviting ludicrous assumptions about steady this and steady that, and ignoring the big buggers such as inflationary spikes, care costs, and (in time no doubt) medical costs.

  22. @ Tyler
    “a simple spreadsheet with an actuarial table ….”
    I trust Glen Dorran will support my contention that one would need to review one’s current state of health, lifestyle and family history of longevity in order to create/select an appropriate table.

  23. As far as I can see the cash withdrawals (apart from the unchanged 25% tax-free) will be taxed at the marginal rate.
    So there is a disincentive to draw more than £40k (unless you defer your state pension in which case £49k) in a single year.

  24. John77 – absolutely agree, which is why Tyler is right that in practice people will use some kind of managed drawdown product, with the provider giving drawdown rates in line with your own experience and attitude to risk.

    Some people will try to do it using their own spreadsheet – including a number of cantankerous actuaries 🙂

  25. people claim that the fees charged for annuities are high, but they are not as high as the fees charged by fund managers. Those who decide to keep their pensions managed by fund managers for longer (rather than buying an annuity) will be putting money into the pockets of fund managers (aka Tory donors) . Also if the market becomes thinner, annuities will probably become more expensive.

    Also people who screw up and spend all their money before they die will fall back on the state. This policy worsens the long run fiscal position of the country.

  26. @ Luis

    People who blow it all will surely have the same right to state support as anyone else? I’d assumed my state pension would be the same irrespective of my private pension.. are there a load of top-up benefits too? What would I get after spunking my private pot on morally ambiguous pursuits that I wasn’t getting before?

    As for handing money to overpaid fund managers.. well that’s a choice for individuals, and we should be educating people about all this stuff so that they can make more informed choices. It’s popular wisdom amongst the financially literate that fund managers aren’t special, and a crude basket of tracker funds does the same job for a fraction of the price. We just need more financially literate people.

  27. @ dearieme/John 77

    You can’t predict the future, but you can plan ahead and around certain eventualities.

    The simplest form of the problem would simply be to take the amount you need to live on per annum, then escalate that by CPI + X (and maybe even escalate X by care costs). Acturial tables are remarkably accurate for a population, and even the addition of a partner reduces a lot of that risk for married couples. You can’t totally remove that risk though without some sort of pooled insurance.

    At this point you might find an annuity is best, but it isn’t too hard to manage yourself. Take your pension pot, less the amount withdrawn per year, and assume some rate of return, maybe as a base just Gilts to simulate the risk free.

    Just this fairly simple system will give you an indication as to when your pension is likely to expire, giving you some information you can use to improve the situation. Better investment returns and your pension pot will last longer or you can live longer without extinguishing it. Be more frugal early in the pension’s life and again, the compound returns help you later.

    It also helps people who hit retirement age who would otherwise be forced into an annuity, at lower rates, when they might have other income and therefore would rather delay taking the pension.

    As I say, it’s not meant to accurately predict the future, just plan better for it, avoiding much of the costs currently associated with an annuity.

  28. @ Luis

    Fees for most funds are significantly lower than the fees for an annuity. Upfront annuities might look better, but in reality the effective charge on real return can be several percent, compared to about 1% on average for fund managers, though you can get cheaper. Do remember that fund mangers also face significant costs running pension money, whereas an annuity is effectively a once off insurance product. Speaking from experience, the insurers providing annuities are really taking the p*ss, the fund managers much less so.

    I also find that some fund managers really earn that money you pay them. Some however, basically buy the index and do little else. Selection is truly important. Or, you can simply do it yourself through buying various indexes/ETFs through a SIPP, cutting most of fees out entirely.

  29. @ Tyler
    You provoke me into saying that CPI+X is a seriously wrong formula. Start off with deciding whether you care enough about the sort of care home that you might require: if no, do not factor in care home costs and rely on the local authority to pay if you run short of cash; if yes, then allocate a sum equal to two years fees at the home of your choice, inflated at service inflation rates and discounted at gilt yields (kept within your pension fund so that you can discount at gross yields) – say the net effect is to inflate them by 1% times 87-your age; next look at the specific cost-of-living index for pensioners – for whom inflation is higher than RPI, let alone the phoney CPI geometrical mean index which anybody with a decent maths ‘O’ level knows understates inflation over two years or more (it does over any period but insignificantly over 1 year); *then* you can use your spreadsheet to calculate the size of the gilt portfolio that you need to provide for care costs plus the income you want until you reach 87. If you are married then you have to add your wife’s expenses less her net-of-tax pension to the desired income.
    Of course, that will not be a level income since you might want to climb Mount Kilimanjaro when you are 66 but not many people will want to do that at 86: Snowdon should be quite enough by then!

  30. @ Glen Dorran
    Thanks, although cantankerous actuaries *I* know tend to use mental arithmetic to check our spreadsheets 😉

  31. John77

    I would say that they are a dying breed, but every new generation of actuarial students I see has at least one who would be happier with a slide rule and a quill pen!

  32. Tim, it’s a “good” thing.

    Ignoring the technicalities of how long you are going to live, it is your money, and in addition to the state pension that you contributed towards.

    Obviously the Curajus State will not be happy as clearly it thought it was its money.

    Off topic – did anyone see this:

    http://blogs.telegraph.co.uk/technology/willardfoxton2/100012871/did-you-spot-this-budget-gives-hmrc-power-to-raid-your-bank-account-like-wonga/

    There really is no stopping them! I can see a growth in funds being moved off shore simply as a sensible precaution.

  33. Tyler, my suspicious mind has got the better of me:

    “Having spent the last couple of years on the buy-side of the financial world looking at pension type stuff, I can say that this undoubtably a good thing for the consumer.”

    What do you do for a living, and are you going to make shedloads of money out of this?

  34. ….and Labour’s Tom Watson confuses tax relief with tax delay
    ““People will tell you that ‘it’s your money, you should decide how to spend it’. The whole point is that it just isn’t that simple. Yes, you paid in. But so did the taxpayer. And the government has every right, therefore, to ask that you spend it in the manner it was intended when we were stumping up the cash.”
    (H/T Guido)

  35. Luke

    I suspect that Tyler and I are on opposite sides of annuity transactions (see my first comment above). I work for one of the eeeeevil annuity providers and (I think) Tyler works for an eeeeeevil investment bank.

    It is possible for us both to think that this is a good proposal for customers without either of us having eeeeeevil intent.

  36. Tom Watson doing more than confusing tax relief and tax delay. He’s also managed to mix up contributions with exemptions.

  37. @ Luke
    It is possible to make a decent living by doing a good job – my butcher is a prime example: because he likes his job he provides a superior service (and better value for money* even though his prices are higher than Tesco’s).
    I am no longer on either side of the Tyler-GlenDorran deals, but forty-odd years ago I worked for a couple of years in “group pensions” and since Brown’s bubble burst, my defined benefit pension from my former employer (for half my working life) has exceeded my earnings so I can look at this from both sides.
    This is an definite improvement for consumers with DC pensions, even if you factor in the sad effect of a handful of idiots who will cash everything in at the first opportunity (paying higher rate tax on some of it). Annuities have been wrecked by artificially low interest rates that are designed to soften the impact of the recession – and, for the male majority the abysmal stupidity of the ECJ that demands unisex annuity rates (I hope that I do not live to see them imposing unisex changing rooms and toilets) – so a lot of people like me are deferring drawing pensions until real interest are positive: the new rules will allow some of us to retire and draw a modestly adequate income until interest rates rise. So, apart from helping those who were going to retire anyway, this will also release some job vacancies for the young..
    *The food is fresher (he buys from the best local farmers), tastes better, a better and wider variety, and he makes sure it is because he eats the unsold leftovers at the end of each day.

  38. Sorry Tyler, that came out ruder than I meant it to. Just gentle teasing.

    Glen and John 77, my (very inexpert ) opinion is that *an* annuity is probably best for nearly everyone. That does not mean that the government should force everyone to use all their cash to buy one, or to buy one at any particular time, or indeed to buy one at all. Partly a matter of liberty, partly a matter of financial planning. So I probably agree with most here.

    And if it’s all a disaster, lots of people will sue lots of people. It’s an ill wind…Pension mis-selling claims kept me going for a couple of years.

  39. @ Luke
    An annuity should be the default option – but *not* when you don’t get your money back (in real terms, and without interest) unless you live well past 90 – and that is before tax!
    The FT gives annuity rates every week and the latest shows the top rate for a 65-year-old’s inflation-linked annuity as 3.55%. If you have to pay tax on some of that then you are better off gradually drawing down capital even if you live to a hundred.
    Denis Thatcher was condemned to living on baked beans for months to illustrate the point that saving was worse than pointless under the Wilson/Healey regime. Cleaning up after Brown, both Darling and Osborne have embraced negative real interest rates so we are back to the position that investors are better off buying an attic-full of baked beans than putting their money on deposit and buying the odd tin when when they want one.

  40. The idea of people having control of their own money seems to have sent many at the Guardian into some kind of melt down.

  41. What’s interesting about all of this is the (possibly, and I strongly suspect unintended*) philosophical consequences of what is, at the simplest level, a change of one interest rate (the tax rate on pension drawings over the TFC limit).

    It is giving people control of what is their own money.

    The share prices of various annuity providers have collapsed, demonstrating the dangers of basing your business on a piece of legislation which can be changed “at a whim”.

    Robert Peston has a piece today about the dire consequences of bond investment drying up – again, if he is to be believed (which I don’t) then an entire economy is reliant on one suite of government legislation.

    *part of me wishes that this is a nice small-state Trojan horse by Osborne; I suspect it’s just a response to Daily Mail. Either way it is a Good Thing.

  42. Incidentally, I was at an actuarial event tonight where I had the opportunity to discuss this with peers from other companies. My entirely unscientific and random poll (ie speaking to people I know) would say that it was about 75-25 in favour of this announcement.

    The general view matches what we’ve said above: a mixture of self-investment, flexible drawdown and annuities. The difference in future will be that people will be able to choose what is most appropriate to their own circumstances. And those that “blow the pot” would do something similar in any event.

  43. Can I tell my mildly racist actuary joke? Well, go on.

    What’s the difference between a Sicilian actuary and an English actuary?

    Take a group of 100 people. The English actuary can tell you how many of them are likely to die in the next year. The Sicilian actuary can tell you their names.

  44. Offshore Observer

    It is not exactly the same system but in Oz superannuation (as we call it) is accessible as a lump sum at age 60 and guess what, it seems to work OK

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